Financial risk taking in East Germany, the former GDR, compared to the West

Pretty much a foregone conclusion one would think, but  one towering Western presence back then when the two parts were united did not excel in financial acumen. Chancellor Helmut Kohl famously promised "green pastures". What he delivered was inequality that extends to this day and he completely miscalculated the costs.

So how do East Germans compare to their brothers & sisters in the West when it comes to investing?

The Long-lasting Effects of Propaganda on Financial Risk-Taking

Christine Laudenbach, Ulrike Malmendier, and Alexandra Niessen-Ruenzi⇤ April 2018

Abstract

We analyze the long-term effects of living under communism and its political propaganda in East Germany (former GDR) for financial risk-taking. Utilizing comprehensive German brokerage data, we show that, decades after reunification, East Germans still invest significantly less in the stock market. Consistent with communist friends-and-foes propaganda, they are more likely to hold stocks of companies in communist countries (China, Russia, Vietnam), and are particularly unlikely to invest in American companies or the financial industry. E↵ects are stronger for individuals for whom we expect stronger emotional priming, for example those living in communist “showcase cities” or cities of Olympic gold medalists. In contrast, East Germans with negative experiences invest more in the stock market today, e. g., those experiencing environmental pollution and suppression of religious beliefs and those without access to (Western) TV entertainment. Election years appear to have trigger e↵ects inducing East Germans to reduce their stock-market investment further. We also provide evidence of negative welfare consequences, as indicated by investment in more expensive actively managed funds, less diversified portfolios, and lower risk-adjusted returns.

Religiosity and environmental concerns impact investment sentiment positively.

"We show that di↵erences between East and West German investors are indeed mitigated in counties with high levels of religiosity. Furthermore, we show that the stock market participation gap is more pronounced in areas that were highly polluted during GDR times. Environmental pollution directly contradicts the claim of the communist regime to protect the environment in the interest of peoples well-being."

East Germans prefer costly investment services which sounds a little strange.

"East Germans investment behavior is costly. They hold less diversified portfolios, more expensive actively managed equity funds and a lower fraction of passive investments such as ETFs or index funds."

And they prefer bond invstments all the while West Germans portfolio size is not surprisingly bigger.

"In spite of the high level of stock market participation in our brokerage data set, East Germans participate significantly less in the stock market than West Germans (61% vs. 87%). While the fraction of stocks is also significantly lower in East German investors’ portfolios (49% vs. 72%), East German investors hold more bonds than West German investors (30% vs. 11%). We also observe that East and West German investors di↵er in characteristics that are related to stock market participation like overall wealth levels. Specifically, we find that West German investors hold significantly larger portfolios, live in counties with higher GDP per capita and higher real estate wealth, and receive higher income. These differences mandate to include proxies for investors’ overall wealth as control variables in our regressions."

Conclusion

We show that long-term experiences of a communist system lead to a lower willingness of East German individuals to take financial risk, even almost 30 years after reunification. Results are stronger for individuals that are more likely to have made emotional experiences with the communist system of the GDR. We propose that even long-term experiences gain impact on individuals’ behavior today, if they are colored by emotions which facilitate their memory retrieval and enhance their relative importance for the individual. Even if these memories may not be relevant from an objective point of view, emotional tagging motivates individuals to put more subjective weight on these memories.

We also show that long-term experiences of the communist GDR system are costly:

East German investors hold less diversified portfolios, more expensive equity funds and less passively managed assets. Our results provide a micro-level foundation for macroeconomic growth di↵erentials between East and West Germany.

It would now be interesting to know how Mutti invests.